Tag Archives: investment advice

Big Bank Problems: A Culture Ratio is More Important Than a Capital One

My Comments:house and pig The financial crisis in 2008-09 could have been much worse. The Federal Reserve intervened and limited the damage. After the fact, the regulators created a major remedy, one intended to “make sure” a similar crisis wouldn’t happen again. The idea was to impose new standards regarding the amount of capital, or reserves, on the books of the banks that were deemed “too large to fail”.

This author suggests it wasn’t enough. Which in turn suggests we’ll have another crisis down the road, only for different reasons. I can hardly wait.

Simon Samuels / November 24, 2014

The focus on making banks ‘safe’ by holding more capital is unrealistic, writes Simon Samuels

Tim Geithner said he realised Merrill Lynch’s risk culture was not in great shape when John Thain, then chief executive, did not know the name of his chief risk officer – who at the time was sitting next to him. The anecdote demonstrates a truth that is in danger of being lost in the regulatory clamour for banks to hold ever more capital: that the driver of bank failure is not insufficient capital but rather a bad “risk culture”.

Think of three pairs of superficially similar banks pre-crisis: Citigroup and JPMorgan Chase; Royal Bank of Scotland and Barclays; Belgian-Dutch lender Fortis and BNP Paribas. In each case, when crisis struck, the first needed a taxpayer rescue; the second did not. Yet here is the odd thing. Entering the crisis the capital strength of each pair was near identical. The overall risk culture, and not capital levels, explained their divergent fortunes.

Today regulators are focused on requiring all banks to hold much more capital as they attempt to make banks “safe”. In practice, however, making all banks “safe” is unrealistic. While RBS was suffering losses of £30bn in the crisis, BNP Paribas was making profits of €34bn. Would it have been right to have set BNP Paribas’ capital requirements in anticipation of RBS-sized losses?

Some say yes, including Robert Jenkins, a former member of the Bank of England’s Financial Policy Committee, who in 2012 put to the industry the idea of a “deal” whereby all new regulation would be suspended in return for a 20 per cent leverage ratio on banks, many times the Basel requirement. In practice, such a measure is a hammer to crack a nut. Much better, surely, would be to demand more capital only from those banks more likely to lose money: those with poor risk cultures.

But it is hard to measure risk culture. Some weaknesses are, in retrospect, obvious. Citigroup’s board included the chief executives of a galaxy of famous US companies who between them had hardly any banking experience. However, a good risk culture is more complicated than knowing who your risk officer is or having banking experts in the boardroom. Entering the crisis, the directors of RBS included a healthy compliment of extremely experienced bankers who – at the time – regulators, investors and analysts regarded as suitably qualified. Between them the five critical boardroom lieutenants of Fred Goodwin, chief executive, had almost 150 years of relevant banking industry experience. Yet, apparently, the culture was not one that encouraged challenge.

The UK’S 2009 Walker report on corporate governance recommended fostering such a culture in boardrooms as part of a strong risk culture. And it is more important than ever today, when the risks remain long after the loan has been repaid or the trade completed, as shown by the billions of dollars banks have paid so far for misconduct in the run-up to, during and after the crisis, including by those banks that did not need a taxpayer rescue to survive the economic meltdown.

But, while much has been done by regulators and policy makers, much more is needed. First, global regulators should disclose their own assessment of a bank’s risk culture. They may well penalise those deemed weak by confidentially requiring them to hold more capital. Disclosing such information – after an appropriate delay allowing the banks time to rectify the situation – will offer banks an incentive to address the problem and provide valuable information to investors.

Second, banks could vary the way they pay directors to reflect their different relationships with risk. By all means pay the chief executive, who will be focused on the bank’s growth, in deferred stock. But it is better, surely, to pay the chief financial and risk officers – both more focused on avoiding dangers – in similarly aligned debt instruments.

Third, banks should reveal their own record at measuring risk by disclosing how their losses each year compare to the level they expected, and providing an explanation for any difference. The International Accounting Standards Board’s IFRS 9 accounting standard takes steps in this direction but does not go nearly far enough.

Finally, banks could disclose the topics discussed and voting patterns at board meetings. Giving investors such an insight may reveal how good the board is at anticipating and managing risk, and how challenging or submissive the boardroom culture is.

Just because culture is harder to measure than capital does not mean it is less important. As Albert Einstein said: “Many of the things you can count don’t count. Many of the things you can’t count really count.”

The writer is a member of the Financial Stability Board’s enhanced disclosure task force. He writes in a personal capacity.

13 Reasons Why a QLAC Belongs in Your IRA

My Comments: Some people made good decisions along the way and now have significantly large IRA accounts. Some people I know have little need for the money to maintain their existing standard of living.

If this is you and would like to find a way to NOT take money every year and pay the IRS a sizeable chunk of your retirement nest egg, there is now a way to defer some of the taxes. You can’t avoid the truism about the inevitability of death and taxes, but you can delay it.

This article explains your new option. If you’d like to know more, send me an email or give me a call. I can help make it happen for you.

By Stan Haithcock / Nov 18, 2014

Qualified longevity annuity contracts (QLACs) were approved on July 1 of this year for use in Traditional IRAs, 401(k)s, and other approved retirement plans.

They’re also referred to as qualifying longevity annuity contracts. Regardless of what name you choose, let’s look at some reasons why you should consider including a QLAC in your IRA:

1. Potentially reduce taxes
The ruling allows you to use 25% of your individual retirement account, IRA, or $125,000, whichever is less, to fund a QLAC. That dollar amount is excluded from your required minimum distribution, RMD, calculations, which could potentially lower your taxes.

2. Lessen your RMDs
As an example, if you have a $500,000 Traditional IRA, you could fund a $125,000 QLAC under the current rules. Your RMDs (Required Minimum Distributions) would then be calculated on $375,000.

3. Plan for future income
QLACs allow you to defer as long as 15 years or to age 85, and guarantees a lifetime income stream regardless of how long you live.

4. Spousal and non-spousal benefits
Legacy benefits for both spouse and non-spouse beneficiaries guarantee that all the money will go to your family, not the annuity carrier.

5. Protect your principal
QLACs are longevity annuity structures, which are fixed annuities. Also referred to as deferred-income annuities (DIAs), the QLAC structure has no market attachments, and fully protects the principal.

6. Add a COLA
Depending on the carrier, you can attach a contractual COLA (cost-of-living adjustment) increase to the annual income or a CPI-U, Consumer Price Index for All Urban Consumers, type increase as well.

7. No annual fees
QLACs are fixed annuities, and have no annual fees. Commission to the agent are built into the product, and very low when compared with fully-loaded variable or indexed annuities.

8. Contractual guarantees only
QLACs are pure transfer of risk contractual guarantees, and agents cannot “juice” proposal numbers.

9. Laddering income
Because of the QLAC premium limitations, this strategy should be used as part of your overall income laddering strategies, and in combination with longevity annuities in non-IRA accounts.

10. No indexed or variables allowed
Variable and indexed annuities cannot be used as a QLAC, which is a positive for the consumer in my opinion. Only the longevity annuity structure is approved under the QLAC ruling.

11. Complements Social Security
QLACs work similarly to your Social Security payments by guaranteeing a lifetime income stream starting at a future date.

12. Indexed to inflation
The QLAC ruling allows the premium amount to be indexed to inflation. That specific amount is $10,000, and should increase by the amount every three to four years.

13. Only the big carriers play
Because of the reserve requirements to back up the contractual guarantees, only the large carrier names most people are familiar with will offer the QLAC version of the longevity annuity structure.

I have recently written an easy to read QLAC Owner’s Manual that clearly explains the law and what you need to know to make an informed decision. In my opinion, it’s worth your time to take a closer look.

Halt Jerusalem’s Unholy Descent Into Dark Ages

My Comments: Writing about politics and religion is outside my professional capacity to serve my clients, friends and family, not to mention those whom I hope to meet in the coming years. It’s much easier to try and ignore this stuff than to admit it has important implications. And then attempt to define just where we are mentally with respect to the issue at hand.

For many years I’ve been a fan of Israel. I’m not far removed from the horrors inflicted on Jews by the German state and the conflict we call World War II. However, I’m less of a fan than I used to be as Israel increasingly allows itself to be defined as just another tribe, whose people happen to live in a part of the world where tribal conflicts have raged for centuries.

For me it’s analogous to my refusal to be defined by any church or religious group. In historical terms the worst atrocities man has ever inflicted on his fellow man resulted from a belief that his God was “better than your God”, therefore “you must die”. For me that demeans the spirit behind all interpretations of God; that we are simply observers of the universe and subject to rules over which we have zero control.

I suspect I’ll not live to see this Jerusalem question resolved. But the following comments by someone with a significant history behind his name are worth a read. It has implications for what we are seeing here in this country today; the conflict between blacks and whites, and the growing discrepancy between the have’s and the have nots. We either accept the need to find remedies and struggle for solutions or it will sooner or later bite us in the ass. And it won’t be painless.

December 1, 2014 / Ghanem Nuseibeh / The Financial Times

The city has seen worse, but today’s problems could spark global conflict, says Ghanem Nuseibeh

Jerusalem, the city at the heart of all three Abrahamic faiths, is undergoing one of the most disturbing episodes in its long history. As the scion of its oldest Arab family, I find the developments of the past few weeks – the bloodshed, yes, but more fundamentally the wave of intolerance – deeply troubling, breaking longstanding pacts between the faiths to share the city and its religious treasures.

My family arrived in Jerusalem in the 7th century with the Arab Muslim army led by caliph Omar bin al-Khattab, companion of the Prophet Mohammed. At that time the city was ruled by the Roman empire, which for centuries had barred Jews from entering. The covenant of Omar – the truce between Omar and Sophronius, patriarch of Jerusalem – included a promise by the city’s new Muslim rulers to protect the Christian inhabitants. There was only one clause that the Christians insisted the Muslims not implement: the condition that Jews would not be allowed back into Jerusalem.

Instead, the Muslim conquest opened the city up to Jewish residents once more. One of my forefathers was a signatory to the covenant of Omar. I am proud to say the Muslim decision to allow Jews to resettle in Jerusalem was a moment of significance in the city’s history. Exclusion and discrimination gave way to tolerance and respect.

My family was entrusted with the custodianship and the key to the Church of the Holy Sepulchre, Christendom’s holiest site, more than 1,400 years ago. Since then, and to this day, we have performed this role – with the only interruption occurring during the crusades in the 11th century. The Christian and Muslim leaders of the day, Richard the Lionheart and Saladin, agreed to restore the Nuseibeh custodianship of the church to keep the peace between the Christian denominations after intra-Christian fighting and bloodshed, often within the holy building itself.

What we are seeing today is not the worst Jerusalem has seen. But it threatens to turn into a global conflict. When the city is caught up in religious strife, the suffering is reflected elsewhere in the region and beyond. Rhetoric and mutual intolerance is spreading, with every incident ratcheting up the sense of gloom and mistrust. A vicious cycle of incitement is creating an unholy race back towards the Dark Ages.

The murders in the past month at the Jerusalem synagogue were a most condemnable act of savagery. So too was the barbaric killing in July of the Arab youth, Mohammed Abu Khdeir – as well as the murders of the Jewish youths for which this was widely seen as revenge – and the dozens of deaths, including those of Arabs, that followed. For many, the city is becoming a place of exclusion, each group attempting to assert control at the expense of the other. This not only goes against our Abrahamic culture, the root of western civilisation, but also the notion of one God and the equal status of His children – Jews, Christians and Muslims.

The great kabbalist, Yehuda Ashlag, taught that the means for correcting the problems in the world are mercy, truth, righteousness and peace. None of these qualities are evident in today’s disputes over possession of Jerusalem’s holiest sites.

The way forward is lit by the heroes of the past. The willingness of Muslim leaders almost 1,400 years ago to allow Jews to live in Jerusalem was matched by Israel’s acceptance in 1967 of control by the Islamic Waqf – the Jordanian religious trust that administers the site – of the city’s al-Aqsa mosque. That spirit needs to be rekindled for our times.

Jerusalem desperately needs a new covenant for its inhabitants, and indeed for the world. Political and religious leaders must reflect the wisdom of the past and express a renewed commitment of respect for each other and for our respective places of worship. We dare not allow our fears and mistrusts to fester and lead to more senseless bloodshed.

The writer is a senior visiting fellow at King’s College London

Falling Gas Prices Fuel Holiday Cheer

My Comments: A good friend of mine who owns several gas stations says he loves it when the price of gasoline falls. The reason: it’s much easier for him to increase his margin of profit when the price is falling than when it’s going up. Everyone loves falling prices so there is less competition among retail outlets. When it’s rising, the game is won by those willing to accept a smaller profit per gallon.

I read this morning that prices in the South may go as low as $2 per gallon. It’s a reflection of our ability to produce more domestically via fracking and an economic slowdown across the planet leading to less demand for oil. Enjoy it while it lasts.

November 21, 2014 / Scott Minerd / Guggenheim Partners

Rising equities and falling prices at the pump will bring holiday cheer, but be aware of potential headwinds as we head into 2015.

Economic data from Japan this week was much worse than expected. Japanese GDP decreased by an annualized 1.6 percent in the third quarter, despite forecasts that it would rebound by 2.2 percent. In Germany, the economy only narrowly avoided falling into a technical recession in the third quarter, expanding at 0.1 percent, a figure that will do little to alleviate concerns surrounding the euro zone’s main growth engine. Economic weakness around the world is being directly translated into the price of oil.

The short-term trajectory of oil prices will depend on a number of factors, including the growth outlook for Europe and Asia, as well as the global supply/demand dynamic. Despite the recent decline in market prices, producers in the Middle East have not yet cut back on production. With fracking having fundamentally increased output in the United States, I suspect that oil is at least ten dollars a barrel away from any kind of price support.

While gas prices at the pump have been heading lower recently, U.S. equities have been moving in the opposite direction. In this regard, the domestic economy will likely benefit from both the wealth effect of rising equity prices, as well as the consumer spending power released by the decline in gasoline prices. Lower gasoline prices act like a tax cut, leaving more money for American consumers to spend on other goods, which is likely to provide the U.S. economy with a boost as we head toward the all-important holiday shopping season.

Despite the positive backdrop for the nation’s economy, the current rally in U.S. equities has still not been confirmed in the NYSE Cumulative Advance/Decline Line and investors would be well advised to monitor this closely. Historically, a persistent divergence between the Dow Jones Industrial Average and the Advance/Decline Line usually leads to a correction in equities. Whether or not the Advance/Decline Line can catch up with the increase in equity prices over the next few weeks will determine whether the current rally is sustainable.

Due to plummeting oil prices, the cost of gasoline in the United States is now at the lowest level since 2010. Gasoline consumption as a share of total spending should fall in the fourth quarter due to lower prices, freeing up income for spending in other areas. Even if gasoline prices remain unchanged for the rest of the year, we project real discretionary consumption should rise by the most since the beginning of 2011, helping to spur GDP growth.

Employers Optimistic About Health Plan Coverage

healthcare reformMy Comments: I make no apologies for my endorsement of the PPACA legislation (ObamaCare). I strongly believe it’s in our best interest as a nation for ALL OF US to be as healthy as possible, for as long as possible. While the cost of transitioning from what we had before may be hard to stomach from time to time, there is a net positive for all Americans to have access to contemporary medicine.

A friend recently sent me a list of 32 nations that already have universal health care coverage. We are not on this list, nor are countries like Brazil and Argentina. Some are really not significant or well populated in the global arena. But consider that Germany, the economic engine of Europe, has had universal health care coverage since 1941. At the time, “universal” meant only those with an Aryan history. But in the post WWII era until today, one cannot claim that national health care coverage limited the economic opportunities for Germans.

There are going to be some changes in the rules for us. Some will be good and some maybe not so good. It’s part of the effort to limit unintended consequences and improve things. But I don’t see it all going away; no one on the right has ever offered a viable alternative.

By Michael Giardina / November 20, 2014

A majority of employers – regardless of workforce size – are planning to keep their health plan coverage going into next year as the Affordable Care Act’s employer mandate takes effect.

In 2015, employer shared responsibility rules become a reality for employers with 100 or more full-time or full-time equivalent employees – for those in the 50-99 employee cohort the rules take effect in 2016. Despite the additional compliance headaches associated with the employer mandate, organizations appear committed to sponsoring health plans for their workers, in part because they view health care benefits as a valuable tool in recruiting and retaining employees, says Andrew Mariotti, a senior researcher at the Society for Human Resource Management.

“It appears that health care benefits are still considered very important by our members for both attracting and retaining prospective employees and current employees,” Mariotti says.

Just 1% of the more than 3,300 HR professionals surveyed in a new study say they are planning to cut health coverage to their employees, according to the Health Benefits Survey from SHRM’s Benchmarking Research and the Employee Benefit Research Institute. For employers with less than 50 employees – the group that has long been rumored to possibly drop coverage when the employer mandate takes effect – Mariotti says just 2.2% plan to stop coverage.

“More of the smaller employers were considering eliminating coverage, but it was still a very low number,” Mariotti explains.

Meanwhile, Mercer finds that the number of employers considering dropping coverage and sending employees to the public health insurance exchanges has reached record lows, at least according to the more than 2,500 employers who participated in Mercer’s National Survey of Employer-Sponsored Health Plans.

Approximately 4.4% of large employers say they will cease offering employees coverage over the next five years, down from the 6% prediction offered in 2013. Also, just 16% of small employers, those in the 50-199 employee range, plan to drop their plans, a drop from last year’s 23%. Lower health care cost trends are a factor in employers’ decisions to keep offering health care benefits, says Beth director of employer research for health and benefits at Mercer.

“If we weren’t seeing this continuing kind of low cost trend, then we might be seeing a different kind of response to the question,” she says. “But I think because employers feel like they have some tools to manage costs, it’s easier for them to picture continuing to offer their benefits programs into the future.”

Another major contributor to this year’s employer confidence in health plan coverage is the rise in high-deductible health plans and resulting increased consumerism among employees. Umland notes that “the consumer-directed health plan is not just a little cheaper – it’s 20% less expensive than the most common plan, the PPO.”

According to Mercer, nearly half of large employers and 72% of jumbo employers added a CDHP to their health plan offering in 2014. Also, CDHP enrollment numbers have jumped to 23% during this time period, surpassing HMO signups. Meanwhile, PPOs fell to 61%.

“These plans [CDHPs] have far surpassed HMOs in enrollment – they are really becoming a pretty dominant health plan type,” Umland says.

Another reason employers are maintaining health benefits is the value these plans can bring to workforce perceptions and company budgets. “If you don’t offer health benefits, not only are you subject to the [ACA] penalty, but then you have to face employees. Very few employers are willing to say: ‘If we just don’t offer you coverage and you have to go buy it yourself, essentially you are getting a huge pay cut because money that would otherwise to available to you to spend, you’ve got to invest in health care,’” says Umland.

Employees will figure out that the “math just doesn’t work” when cutting benefits because increasing compensation “doesn’t have the same tax exclusions that you get with money that’s spent on health benefits,” says Umland.

All roads lead to the ACA’s excise tax in 2018 – a 40% tax on employers that provide high-cost health benefits to their employees. In the benefit industry’s canvassing by SHRM and EBRI, 85% of respondents do not expect their organization to hit the tax in 2018. In Mercer’s sample, estimates are that a third of employers could trigger the tax if they take no action and maintain current plan structures.

Bull Market Of A Lifetime May Be In 5th Inning

My Comments: According to this author, doom and gloom is a long way away.

Whatever the case, it is my heartfelt wish that all of you have a wonderful and happy Thanksgiving.

Hopefully, you will spend time with those who mean the most to you. While all of us have worries, there is so much to be thankful for. I’m alive, reasonably healthy and my closest family members will be here in the house with my bride of 44 years. The next generations will be here as well, learning about the joy of loved ones, the pleasure of each others company and too much to eat. We are blessed.

October 28, 2014 • Evan Simonoff

One of the greatest bull markets of most Americans’ lifetime may be in the 5th inning, according to Richard Bernstein, CEO of the eponymous advisory firm. Canvassing the global investment landscape, Bernstein told reporters at a luncheon sponsored by Eaton Vance that few signs of a recession or a bear market are on the horizon. He also sees no reason to change his highly negative outlook on emerging markets.

Bernstein’s words carry weight. A former chief market strategist at Merrill Lynch, he was named best in his discipline by Institutional Investor magazine 10 times. He was also an early and vocal optimist about the current bull market back in 2011 and 2012. In 2012, Bernstein predicted the current bull market might surpass the 17-year run from 1982 to 1999.

The surge of volatility in virtually every asset class that pervaded the financial markets earlier this month is attributable to the fact that hedge funds have been caught flat-footed, underperforming major indexes this year, Bernstein said. Hedge funds argue their reason to exist is that they will protect clients on the downside, even if they underperform on the upside.

In fact, the data reveals that very few hedge funds entered September with short positions of any significance since many of them were playing catch up. The subsequent sell-off in numerous asset classes that transpired in early October was “emotional, not fundamental,” Bernstein said.

The same was true with the lonely asset classes that appreciated. There was nothing “rational” about 10-year Treasurys yielding 1.88 percent, he noted.

But why does Bernstein believe that the bull market in equities still has staying power after climbing about 200 percent off its March 2009 lows? “The behavior that sows the seeds” of future recessions and bear markets “is nowhere to be seen.” Corporations aren’t spending aggressively and consumers refuse to loosen their belts.

The prevalence of the word “uncertainty” is critical to a long economic and equity-market cycle and it remains ubiquitous, he said. In this environment, “err on the side of bullishness.”

Bernstein views investors’ focus on the Fed and Washington, D.C., as a misplaced distraction. “When the Fed raises rates, they will be the last to know,” he said. “Everyone else will know by then.”

Conventional wisdom contending that bull markets end when the Fed raises rates are dead wrong in his view. “They end when the Fed raises rates too much and the yield curve inverts. We are nowhere near that.”

He also took issue with the perception that a near-term increase in interest rates could derail the bull market. “The notion that interest rates will go up and nominal economic growth will go nowhere just is not going to happen.”
Bernstein’s optimistic views on the economy were echoed by Kathleen Gaffney, Eaton Vance vice president of investment-grade fixed income and a highly regarded portfolio manager in her own right. While Bernstein manages several Eaton Vance equity funds as a sub-advisor, Gaffney runs a top-performing bond fund.

She believes that the world is witnessing a “changing of the guard” as the U.S. re-emerges as the driving force behind global growth and that favors equities over bonds. “We’ve haven’t been there [a global economy where the U.S. is the primary driving force] for 20 years,” she noted.
Gaffney didn’t say it, but one reason the price of oil has collapsed so dramatically in the last month is that it was estimated U.S. oil production, whcih increased by almost one million barrels a days in 2014, would do exactly the same in 2015. At this point, all bets are off, as oil markets struggle to discover a new equilibrium price.

Gaffney thinks the yield curve will start to flatten and this will cause high-yield bonds to be repriced. “Equities are a risk worth taking,” she said. Her bond fund has 20 percent of its assets in cash and she wouldn’t mind having more. But as Bernstein observed, bond fund managers as a group have their durations as short as they have ever been.

One of the few spots in the bond market that Bernstein likes is high-yield municipal bonds. Why? Because high-yield U.S. munis are yielding 125 basis points more than Iraq’s sovereign debt. Before ISIS overran much of Iraq, low-rated American municipal bonds were paying 2 percent more.

America may have Detroit and Stockton, Calif., but one quarter of the nation is not controlled by the likes of ISIS. Yet the flood of money into emerging markets’ debt has driven their prices to the point where such pricing distortions are occurring the global bond market.

So what could go wrong? Europe for one. “The European Central Bank will go down in history as the worst ever,” Bernstein said. “They have violated every basic rule of central banking.” In fact, he noted the ECB has been tightening for the last two years while Europe’s corporate sector has been deleveraging and many European nations have been teetering on the brink of another recession.

Bernstein also remains unusually bearish on emerging markets. In his view, they were the major beneficiary of the global credit-market boom of the previous decade and they will continue to be a leading victim of deleveraging.

Inflation and low wages have been triggering riots and protests in many emerging nations, starting in 2011 with the Arab spring and spreading to more established countries like Brazil and Turkey this year. “Why is that a good story?” Bernstein asked, adding that it might be if you were invested in tear gas and mace.

When The Stock Market Performs Best During A U.S. President’s 4-Year Term

profit-loss-riskMy Comments: Many of us are climbing a wall of worry about our investments over the next 12 months. I’m not worried if your time horizon is ten years or more, but if it’s less, then I believe you have reason to be worried.

Every week I’ve posted articles that justify the wall of worry. As soon as I’ve hit the “post” button, however, along comes something that seems legitimate to make me question my reasoning. Here’s another. And it’s not the only one.

Willow Street Investments, Nov. 18, 2014

• An average investor needs to know about the interrelationship between politics, economics, and the stock market to make more informed investment decisions.
• Incumbent presidents push for votes by proposing tax reductions, increasing spending on specific government programs and/or pushing for lower interest rates as an election draws near.
• The most favorable period for investing during a presidential cycle is from October 1 of the second year of a presidential term to December 31 of the fourth year.
• Barring a severe global and economic event, all major stock market declines have occurred during the first or second years of the four-year U.S. presidential cycle.
• Barring a severe global and economic event, no major declines occurred during the third or fourth years of a presidential cycle.

Investors in the stock market are always looking to past history to try and gain an edge for their investing strategy in the future. Frequently, gazing at stock market history in relation to political, economic and social events can provide investors with a window into the future of what may happen in the stock market. Other times, however, the weighted expectations of investors relying too much on history may alter what can be seen through the window to the future because an investors’ expectations of one scenario occurring may be altered by investors own behavior. Like the Farmer’s Almanac, that professes to be able to make long-term yearly weather forecasts for all across the U.S., stock market truisms such as “the January effect,” “Sell in May and Go Away,” and “the Santa Claus rally” are discussed one every year or so as predictive devices to aid in an investor’s investing strategy. Another stock market truism is looking at the 4-year U.S. presidential cycle and the behavior during such cycle.

Recently, we were reviewing an insightful article entitled The Four-Year U.S. Presidential Cycle and the Stock Market by Marshall Nickles and Nelson Granados. This article references a 2004 article, “Presidential Elections and Stock Market Cycles” written by Marshall Nickles. In Mr. Nickles’ earlier article, he noted that all of the major stock market declines occurred during the first or second years of the four-year U.S. presidential cycle. He also noted that no major declines occurred during the third or fourth years of a presidential cycle. In particular, from 1950 to 2004 (using the Standard and Poor’s 500 Index), the most favorable period (MFP) for investing was from October 1 of the second year of a presidential term to December 31 of the fourth year. The remaining period, from January 1 of the first year of the presidential term to September 30 of the second year, was the least favorable period (LFP) for stock market investors. The author concluded in their first article that “it appeared that politicians were anxious to exercise policies that were designed to pump up the economy just prior to a presidential election, which in turn had a positive affect on stock prices.”

In the second article by the authors they attempted to understand and explain the relationship between politics and stock market behavior. They focused on providing evidence of the relationship between economics, politics, and the four-year presidential cycle; and second, including an analysis of stock market performance during the 2008 period. They introduced a risk measurement for the stock market by arguing that the 2008 stock market crash should be considered an anomaly and concluded that the four year presidential stock market cycle is likely still intact. The goal of the article, according to the authors, was to provide evidence that risk may be reduced and returns may increase when an investor considers how economic policy influences stock market prices during the presidential election cycle.

The authors state what may seem obvious to even the most novice of stock market investors. They note that once a president takes office, they realize that to get reelected they must try to make the economy as healthy as possible four years later. Every president faces such circumstance and the authors note that “it is this consistency in the U.S. political process that also sets into motion fiscal policies that are frequently predictable and that often have a direct effect on the stock market.” In the discipline of economics, fiscal policy is defined as an increase or decrease of taxes and or government spending. The direction that fiscal policy takes can often be directly related to the state of the economy at the time a new president is elected.

The authors point out that it is not surprising to see incumbent presidents push for votes by proposing tax reductions and or increasing spending on specific government programs as an election draws near. In addition, an incumbent political party may also try to persuade the Federal Reserve to complement the administration’s efforts through monetary policy, by increasing the money supply and reducing interest rates. Such fiscal and monetary policies may be introduced as early as the end of the second year of the presidential four-year term. If the results are favorable and the economy responds positively, corporate profits will likely rise, and so will stock prices, just as the next presidential election is about to take place.

The authors also set forth the potential negative consequences of stimulating the economy by pointing out that the policies used to stimulate the economy and the stock market can also lead to inflation, which can be disconcerting to investors. If inflation occurs, a new president may be pressured to reverse the fiscal and monetary stimulus policies of the prior president, attempt to get inflation under control, and then hope to return to stimulus policies by midterm in preparation for the next election. Rising interest rates often lead to increased costs for businesses and consumers, which can slow spending and corporate profits, and pressure stock prices downward.

The articles point out and provide evidence that show the DJIA rises during the second half of the four-year presidential cycle. The authors point out the MFP within the four year presidential cycle. Such period begins on October 1 of the second year of the presidential term through December 31 of the fourth year. Such period performed significantly better than the unfavorable period, from January 1 in the first year of the presidential term through September 30 of the second year. The authors point out that the cycles of any type are not always perfectly aligned. Such alignment can be thrown off the authors point out when there are positive and negative macroeconomic events that can temporarily break a long standing the most favorable period cycle. They indicate that even with a history of positive market gains during such most favorable market periods from 1950 to 2004, the 2008 market collapse, precipitated by domestic and global economic events, was too powerful for the market to overcome. The authors conclude that while such economic 2008 market collapse was an isolated occurrence, they do not believe such event will be the only exception in the future. They believe that globalization and the Internet are at least two reasons for volatility and uncertainty in the years ahead. The authors sum up by stating, and we agree, the more the average investor knows about the interrelationship between politics, economics, and the stock market, the more informed they will be in making investment decisions.

Our conclusion

We believe that the authors provide powerful evidence and a detailed discussion of how politics influence the stock market. As the authors point out, what they label as a most favorable periods and least favorable periods typically hold true within each president’s four year term barring exceptions where stimulus activities cannot overcome severe global and economic negative circumstances. So what does the upcoming last year of President Obama’s presidency hold for the stock market? It is true that President Obama cannot run for a third term as president as he is barred from doing so (and whether the public wants him or not). So, President Obama is not worried about getting reelected. It is also likely true that, President Obama would like a fellow Democrat to be elected as President. So, it is likely his fiscal policies will likely continue to boost the economy and the stock market.

If one follows the data presented by the authors of the above articles, 2015 will be a good year for the stock market unless a severe global or economic event occurs. And what about the much discussed interest rate increases that may start to occur in 2015?  Well, such interest rate increases, however moderate they may be, will have a lagging effect on the market that would most likely occur in 2016 after the presidential election has occurred. If the overall market indexes gain next year, do not expect the markets to go straight up but experience volatility along the way. It is during such volatility on the downside that investors should consider establishing new positions.